The definition of commercial banking can depend, to some extent, on who you talk to. This can be one of those shifty terms that fall into a couple of categories. The lines are a little blurred between commercial banks and some other types of institutions offering financial services.
In the simplest terms, the institution that holds onto your money for you and lets you spend it as you see fit is a commercial bank. The issue gets a bit more complicated from there.
What Is a Commercial Bank?
A commercial bank is a “depository institution.” It’s any privately-held bank that accepts money placed on deposit, and it makes loans to others from those funds. Privately-held in the banking context generally means that the institution is owned by shareholders.
The question becomes who the bank is accepting money from, and who it’s making loans and providing other services to. Some financial gurus confine the definition of commercial banking to institutions that only serve businesses, institutions and governments. These banks won't provide Joe Consumer with a personal loan or a checking account. They're always considered to be commercial banks. The businesses they serve might be small, medium or large.
But many commercial banks service both consumers and business, institutional and banking clients without drawing a line between the two. These are usually considered to be commercial banks as well, even if they serve only small businesses or if the bulk of their services are provided to individuals. The defining line is typically whether they offer their services to any businesses at all.
The largest banking institutions, such as JPMorgan Chase, dedicate one arm or unit to commercial banking. For example, JPMorgan Chase has Chase Bank.
Other Common Names for Banking Services
More confusion stems from the multiple names given to banking institutions, and a few of them overlap. Commercial banking is sometimes referred to as retail banking. The term “retail” is used to seeparate services provided to consumers from those provided to business and governmental entities, and the bank can do both. These two terms are sometimes used to differentiate between personal services that are only provided to consumers and those that are only provided to corporate, business, governmental and/or institutional services.
Investment banks are a whole different thing. They invest in securities and currency. The Banking Act of 1933 effectively plucked these institutions from the big pool, firmly separating them from commercial banking institutions, although the law was repealed in 1999. Investment banks generally don’t take deposits, and they don’t provide loans. They deal only with very large businesses, hedge funds, pension funds and institutional investors. They assist with mergers and acquisitions. Commercial banks aren't part of the capital market that deals with trading securities.
Nor do commercial banking institutions include credit unions. By definition, these are owned by their members, not shareholders, so they’re disqualified from being considered commercial banking institutions in the first place.
How Services Are Provided to Consumers
The banking products provided by commercial banks are generally the same whether they’re offered to consumers or businesses. They include deposit accounts, such as savings, checking, money markets and certificates of deposit, and they make loans to their customers. These two services interact, at least from the bank’s perspective.
Banks provide a variety of services when you open an account with them. They make your money easily accessible through tools like ATMs and debit cards. They honor checks you write and electronic payments that you authorize from your account. They pay interest on these accounts, although it’s usually minimal on checking and run-of-the-mill savings. This entices consumers into giving them their money rather than tucking it into their sock drawers.
They then charge interest when they lend money through auto loans, mortgages, personal loans, credit cards and small business loans. This interest rate they charge is always higher than what they pay on deposits, and they charge other fees to depositing customers as well, so they end up making money. The money they loan is drawn from the deposits made with them.
But not to worry – you won’t lose your savings account because your bank has “given” your money to some other guy who wanted to purchase a new SUV. The Federal Deposit Insurance Corporation, or FDIC, insures all deposit accounts made to banks up to $250,000. You’ll get your money back if your banking institution overextends itself and goes bankrupt.
Read More: How Does a Debit Card Work?
Services Provided to Businesses
Services provided to business, governmental and institutional entities go a step or two further. A commercial banking institution – or the arm of the bank that’s dedicated to business commercial banking – might provide payment processing services and assistance with benefits plans as well through a relationship manager.
Online Banks vs. Brick-and-Mortar Banks
A commercial bank can be a brick-and-mortar institution like that big, ornate building on the corner of Main Street, or it might exist solely online. Many commercial banks fit into both categories. You can visit them in person, or you can tap your tablet or phone for assistance when you need it, even to the point of making deposits.
And those big, pretty land-based buildings that brick-and-mortar institutions provide – not to mention their human personnel standing by ready to serve you face-to-face – cost a fair bit of money to maintain. You’ll typically find that online-only commercial banks pay better interest rates on their deposit accounts and that they charge a little less in the way of fees for this reason.
Read More: Advantages and Disadvantages of Internet Banking
Who Regulates All This?
Commercial banking isn’t a free-for-all where these institutions can effectively do whatever they like with your money. There’s that FDIC insurance covering your deposit, for one thing. But banks have to apply for this, requesting a charter or licensure from the federal government and becoming a member of the Federal Reserve System. Don’t just assume your bank is FDIC-insured. Most reputable banks are, but you’ll want to check to be sure.
Commercial banks must also be chartered or licensed by each state in which they operate. There’s a somewhat significant application and approval system in place for this.
Commercial banks are regulated by their country’s central bank as well, which creates rules that they must abide by and acts as a watchdog to make sure they do. One such requirement is that banks must deposit “reserves” with them, diverting a percentage of the deposits made to them into the central bank’s keeping and protection. The purpose is to protect consumers against a national calamity that might have everyone running to their banks at the same time to withdraw every dime to their names. Think of it as a backup to the FDIC provision.
- TheStreet: Retail Banking vs. Commercial Banking
- Corporate Finance Institute: What Is a Commercial Bank?
- Investopedia: Commercial Bank
- iGrad: Am I a Customer or a Client? The Functions of Commercial Banks
- InvestingAnswers: Commercial Bank
- Federal Deposit Insurance Corporation. "Understanding Deposit Insurance." Accessed Aug. 19, 2020.
- Federal Reserve History. "Financial Services Modernization Act of 1999, Commonly Called Gramm-Leach-Bliley." Accessed Aug. 19, 2020.
- Federal Reserve System. "Large Commercial Banks." Accessed Aug. 19, 2020.
- Bank of America. "Who We Are." Accessed Aug. 19, 2020.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.